Macroeconomics Questions (policy, laffer curve, MPS etc.)

Thank you for any help that you can provide. I've stated the questions below:

1. Describe the two key tools of monetary policy, and describe how they would be used by the Bank of Canada to implement a contradictory monetary policy.

2. The economy of Kenya is in recession, and the recessionary gap is large. The World Bank hires you as its economist and asks you to explain the argument that lower corporate tax rates can increase tax revenue in Kenya. Consider the Laffer curve in your explanation.

3. Explain the concept of the multiplier, and explain the role of the marginal propensity to save (MPS) in determining the size of the multiplier.

- Explain how the size of the multiplier will change when one brings in the role of the marginal tax rate.
- Using the concepts in parts a and b above, calculate the slope of the AE curve and the size of the multiplier if MPS = 0.20. Then, calculate the revised slope of the AE curve and the multiplier when you know that the imports and the marginal tax rate will reduce the slope of the AE curve by another 0.25.

4. Describe an export subsidy, and explain the gains and losses that might arise from such practice.

Solution Preview

1. Describe the two key tools of monetary policy, and describe how they would be used by the Bank of Canada to implement a contractionary monetary policy.

Two key tools are the interest rate (basically the cost of money to banks) and reserve requirements (how much banks are required to hold against their lending). If the BoC raises interest rates, it becomes more prudent to hold money in savings, as well as increasing the cost of capital to banks and thus to the economy. Raising interest rates will take money out of the economy and is thus contractionary. Similarly, raising the reserve requirement means bank have to keep more money in their vaults, and thus will have less to lend. In a fractional-reserve banking system, higher reserve requirements means less money pumped into the system, and is also contractionary.

2. The economy of Kenya is in recession, and the recessionary gap is large. The World Bank hires you as its economist and asks you to explain the argument that lower corporate tax rates can increase tax revenue in Kenya. Consider the Laffer curve in your explanation.

The Laffer curve postulates that there is a concave relationship between tax rates and tax revenue, and that if the tax rate is too high, by lowering tax rates you can increase ...

Solution Summary

A myriad of questions in macroeconomics, including a look at Keynesian theories on the Laffer curve, propensity to save, and multipliers.